Keep INVESTING Simple and Safe (KISS)
****Investment Philosophy, Strategy and various Valuation Methods****
The same forces that bring risk into investing in the stock market also make possible the large gains many investors enjoy. It’s true that the fluctuations in the market make for losses as well as gains but if you have a proven strategy and stick with it over the long term you will be a winner!****Warren Buffett: Rule No. 1 - Never lose money. Rule No. 2 - Never forget Rule No. 1.

Sunday, 14 August 2016

A Random Walk Down Wall Street - Part Four 4: A Practical Guide for RANDOM WALKers and other Investors

Chapter 15. Three Giant steps down Wall street

I. The no-brainer step: investing in index funds:
1. The S&P 500 index beat approximately two-thirds of professional managed portfolios in the 1980s and 1990s. Index funds have regularly produced rates of return exceeding those of active managers by close to 2%.

Two reasons:
a. Much lower management fees: public index funds typically charge a fee of 0.2%, while actively managed public mutual funds charge annual management and market expenses that on average are 1.5%.
b. Less trading costs: index funds trade only when necessary, whereas active funds typically have a turnover rate close to 100%, and often even more. Such turnover probably costs the fund at least another 0.5-1% of performance a year.

2. Index funds are also relatively predictable. When you buy an actively managed fund, you can never be sure how it will do relative to its peers. When you buy an index fund, you can be reasonably certain that it will track its index and that it is likely to beat the average manager handily.

3. The index fund has another attraction for small investors. It enables you to obtain very broad diversification with only a small investment. It also allows you to reduce brokerage charges.

4. Many people incorrectly equate indexing with a strategy of simply buying the S&P 500 index. The S&P 500 omits the thousands of small companies that are among the most dynamic in the economy. Thus, I now believe that if an investor is to buy only one U.S. index fund, the best general U.S. index to emulate is the broader Wilshire 5,000 – Stock Index – not the S&P 500.

6. There are index funds holding REITs and bonds. 7. Keep in mind: I am assuming here that you hold most if not all of your securities in tax-advantaged retirement plans. Certainly all of your bonds should be held in such accounts. Furthermore, you may want to alter the percentages somewhat depending on your personal capacity for and attitude toward risk.

II. The do-it-yourself step: potentially useful stock-picking rules 1. Indexing is the strategy I most highly recommend for individuals and institutions. For those who insist on playing the game themselves, I proposed four rules for successful stock selection.

2. Rule 1: Confine stock purchases to companies that appear able to sustain above-average earnings growth for at least five years.Consistent growth not only increases the earnings and dividends of the company but may also increase the multiples that the market is willing to pay for those earnings. 3. Rule 2: Never pay more for a stock than can reasonably be justified by firm foundation of value.Although I am convinced that you can never judge the exact intrinsic value of a stock. I do feel that you can roughly gauge when a stock seems to be reasonably prices. The market price-earnings multiple is a good place to start: you should buy stocks selling at multiples in line with, or not very much above, this ratio. My strategy, then, is to look for growth situations that the market has not already recognized by bidding the stock’s multiple to a large premium. Some people call this a GARP (growth at a reasonable price) strategy. Buy stocks whose P/E’s are low relative to their growth prospects. 4. Rule 3: it helps to buy stocks with the kinds of stories of anticipated growth on which investors can build castles in the air. People are emotional – driven by greed, gambling instinct, hope, and fear in their stockmarket decisions. This is why successful investing demands both intellectual and psychological acuteness. Stocks are like people – some have more attractive personalities than others. The key to success is being where other investors will be, several months before they get there.

5. Rule 4: Trade as little as possible. My own philosophy leads me to minimize trading as much as possible. I am merciless with the losers, however. With few exceptions, I sell before the end of each calendar year any stocks on which I have a loss. The reason for this timing is that losses are deductible for tax purposes, or can offset gains you may already have taken.

III.The substitute-player step: hiring a professional Wall street walker
Instead of trying to pick the individual winners (stocks), pick the best coaches (investment managers). But be very careful:

1. Many fund advertisements are quite misleading. The number one ranking is typically for a self-selected specific time period and compared with a particular (usually small) group of common stock funds.

2. It is simply impossible for investors to guarantee themselves above-average returns by purchasing those funds with the best recent records because there is no consistent long-run relationship between performance in one period and investment results in the next.

3. If you have to pick a fund, use the Morningstar mutual-fund information service, which is one of the most comprehensive sources of mutual-fund information an investor can find. The reports indicate whether the fund has nay sales charges (load fees) and shows the annual expense ratios for the fund and the percentage of the fund’s asset value represented by unrealized appreciation. If you buy actively managed funds you should look for no-load, low-expense funds with little unrealized appreciated to minimize future tax liability.

4. A Primer on Mutual-fund costs. There are two broad categories of costs: “load” fee charged when you buy or sell shares and “expense charges” that are taken out of your investment returns each year.

Loading Fees:
a. Front-end load: a commission charge that is paid when you purchase fund shares. Front-end loads are often as high as 5.75%. So-called low-load funds charge only a 1 to 3% sales charge. Best of all are no-load funds, which have no front-end sales charges at all.
b. Back-end loads and exchange fee. Back-end loads are charges incurred when you redeem fund shares. The charge could be as much as 6% of the value of your redeemed shares if you sell out in the first year, with a declining percentage charge in subsequent years.

Expense charges:
a. Operating and investment management expenses. A fund’s
expense ratio expresses the total operating and investment advisory
fees incurred by the fund as a percentage of the fund’s average net
assets. These expense ratios range from less than 0.2% to 2%. Beware the
loss leader come-on. Some new funds temporarily waive all fees to
enhance the advertised current yield. Investors should be alert to the
fact that they will be socked for full expenses as soon as the
introductory “come-on” period ends.
b. 12b-1 charges: these are fund-distribution expenses charged not as
a front-end load but rather as a continuing annual charge against
fund assets. The “12b-1” refers to an SEC rule that permits these charges. More than half of the publicly offered mutual funds have
12b-1 fees.

IV.The Malkiel step

1. Sometimes, close-end funds have attractive discounts. During the late 1970s,
the discounts ran as high as 40%. My own explanation for the discounts ran
in terms of unexploited market inefficiency and I urged investors to take full
advantage of the opportunity for as long as it lasted.

2. Discounts have narrowed significantly on U.S. closed-end funds. I think the
fundamental reason for the narrowing is that our capital markets are
reasonably efficient. The market may mis-value assets from time to time,
creating temporary inefficiencies. But the financial laws of gravity will
eventually take hold and true value will out.

3. If discounts of 20% or more exist, it is time to buy closed-end funds.

A Random Walk Down Wall Street - The Get Rich Slowly but Surely Book Burton G. Malkiel
http://people.brandeis.edu/~yanzp/Study%20Notes/A%20Random%20Walk%20down%20Wall%20Street.pdf

Value of an Asset

From The Essays of Warren Buffett: “In Theory of Investment Value, written over 50 years ago, John Burr Williams set forth the equation for value, which we condense here: The value of any stock, bond or business today is determined by the cash inflows and outflows—discounted at an appropriate interest rate—that can be expected to occur during the lifetime of the asset.”

Mr. Market is there to be taken advantage of. Do not be the sucker instead. BFS;STS.

Always buy a lot when the price is low.

Never buy when the stock is overpriced.

It is alright to buy when the selected stock is at a fair price.

Phasing in or dollar cost averaging is safe for such stocks during a downtrend, unless the price is still obviously too high.

Do not time the market for such or any stocks.

By keeping to the above strategy, the returns will be delivered through the growth of the company's business.

So, when do you sell the stock? Almost never, as long as the fundamentals remain sound and the future prospects intact.

The downside risk is protected through only buying when the price is low or fairly priced.

Tactical dynamic asset allocation or rebalancing based on valuation can be employed but this sounds easier than is practical, except in extreme market situations.

Sell urgently when the company business fundamental has deteriorated irreversibly.

You may also wish to sell should the growth of the company has obviously slowed and you can reinvest into another company with greater growth potential of similar quality. However, unlike point 16, you can do so leisurely.

In conclusion, a critical key to successful investing is in your stock picking ability.

My Philosophy and Strategy

DOCUMENTRY- WARREN BUFFETT THE WORLDS GREATEST MONEY MAKER

Peter Lynch

11 Lessons From Peter Lynch

Peter Lynch taught me:

1. Behind every stock is a company. Find out what it’s doing.2. Never invest in any idea you can’t illustrate with a crayon.3. Over the short term, there may be no correlation between the success of a company’s operations and the success of its stock. Over the long term, there’s a 100% correlation.4. Buying stocks without studying the companies is the same as playing poker – and never looking at your cards.5. Time is on your side when you own shares of superior companies.6. Owning stock is like having children. Don’t get involved with more than you can handle.7. When the insiders are buying, it’s a good sign.8. Unless you’re a short seller, it never pays to be pessimistic.9. A stock market decline is as predictable as a January blizzard in Colorado. If you’re prepared, it can’t hurt you.10. Everyone has the brainpower to make money in stocks. Not everyone has the stomach.11. Nobody can predict interest rates, the future direction of the economy, or the stock market. Dismiss all such forecasts and concentrate on what’s actually happening to the companies in which you’ve invested.

Lynch’s advice had a profound effect on my stock market approach. He taught me that investment success isn’t the result of developing the right macro-economic view or deciding when to jump in or out of the market. Success is about researching companies to identify those that are likely to report positive surprises.

Think of your physical, mental and social well-being. Money may not buy happiness.

What is Risk?

The major RISK facing you is the possibility of not reaching your long-term investment goal through the growth of your funds in real terms. And the greatest enemy of reaching those goals is INFLATION. Nothing is safe from inflation. Short-term price volatility is NOT risk for investors who have time horizons 5, 10, 15 or 30 years away. Volatility is the friend of the long term investor. The most important friends of your investment goal are COMPOUNDING and TIME.

Life Cycle of A Successful Company

Capital Expenditure

A great company with a Durable Competitive Advantage will have a ratio of Capital Expenditures to Net Income of less than 25%. Less is better.

Capital Expenditures are expenses on:- fixed assets such as equipment, property, or industrial buildings- fixing problems with an asset- preparing an asset to be used in business- restoring property- starting new businesses

A good company will have a ratio of Capital Expenditures to Net Income of less than 50%.

A great company with a Durable Competitive Advantage will have a ratio of less than 25%.

The best stock investment strategy

Keep it simple. Keep it safe (make money with less risk taking). You don't need to pick the best stock or even the best stock funds to do well, if you have an investment strategy that keeps you out of trouble.

Benjamin Graham's 113 Wise Words

The true investor scarcely ever is forced to sell his shares, and at all times he is free to disregard the current price quotation. He need pay attention to it and act upon it only to the extent that it suits his book, and no more. Thus the investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage. That man would be better off if his stocks had no market quotation at all, for he would then be spared the mental anguish caused him by other persons' mistakes of judgement."

Philip Fisher's Wise Words

"The refusal to sell at a loss, while completely natural and normal, is probably one of the most dangerous in which we can indulge ourselves in the entire investment process.

More money has probably been lost by investors holding a stock they really did not want until they could 'at least come out even' than from any other single reason. If to these actual losses are added the profits that might have been made through the proper reinvestment of these funds if such reinvestment had been made when the mistake was first realized, the cost of self-indulgence becomes truly tremendous."

(Common Stocks and Uncommon Profits)

Visualization Video for a New Life

All equity security investments present a risk of loss of capital

Investment performance is not guaranteed and future returns may differ from past returns. As investment conditions change over time, past returns should not be used to predict future returns. The results of your investing will be affected by a number of factors, including the performance of the investment markets in which you invest.

The Ultimate Hold-versus-Sell Test

Here is the overriding primary test, followed by observations on why it is so critically important:

Knowing all that you now know and expect about the company and its stock (not what you originally believed or hoped at time of purchase), and assuming that you had available capital, and assuming that it would not cause a portfolio imbalance to do so, would you buy this stock today, at today's price?

No equivocation. Yes or no?

Answers such as maybe or probably are not acceptable since they are ways of dodging the issue. No investor probably buys a stock; they either place an order or do not.

Here is the implication of your answer to that critical test: if you did not answer with a clear affirmative, you should sell; only if you said a strong yes, are you justified to hold.

Some thoughts on Analysing Stocks (KISS)

Ideally a stock you plan to purchase should have all of the following charateristics:

• A rising trend of earnings dividends and book value per share.• A balance sheet with less debt than other companies in its particular industry.• A P/E ratio no higher than average.• A dividend yield that suits your particular needs.• A below-average dividend pay-out ratio.• A history of earnings and dividends not pockmarked by erratic ups and downs.• Companies whose ROE is 15 or better.• A ratio of price to cash flow (P/CF) that is not too high when compared to other stocks in the same industry.

Benjamin Graham

"To achieve satisfactory investment results is easier than most people realise; to achieve superior results is harder than it looks."

Sell the losers, let the winners run.

Losers refer NOT to those stocks with the depressed prices but to those whose revenues and earnings aren't capable of growing adequately. Weed out these losers and reinvest the cash into other stocks with better revenues and earnings potential for higher returns.

Margin of Safety Concept: Stocks should be bought like groceries, not like perfume

The high CAGR in the early years of the investing period, due to buying at a discount, tended to decline and approach that of the intrinsic EPS GR of the companies over a longer investment time-frame.

Chapter 20 - “Margin of Safety” as the Central Concept of Investment

A single quote by Graham on page 516 struck me:

Observation over many years has taught us that the chief losses to investors come from the purchase of low-quality securities at times of favorable business conditions.

Basically, Graham is saying that most stock investors lose money because they invest in companies that seem good at a particular point in time, but are lacking the fundamentals of a long-lasting stable company.

This seems obvious on the surface, but it’s actually a great argument for thinking more carefully about your individual stock investments.If most of your losses come from buying companies that seem healthy but really aren’t, isn’t that a profound argument for carefully studying any company you might invest in?

Market Fluctuations of Investor's Portfolio

Note carefully what Graham is saying here. It is not just possible, but probable, that most of the stocks you own will gain at least 50% from their lowest price and lose at least 33%("equivalent one-third") from their highest price -regardless of which stocks you own or whether the market as a whole goes up or down.If you can't live with that - or you think your portfolio is somehow magically exempt from it - then you are not yet entitled to call yourself an investor.